Next I analysed the relation between two fund characteristics with performance: fund size (total assets under management) and sequence. The results regarding fund size are evidence against the hypothesis. Instead of a positive and concave relation between size and performance, the results suggest that there is a negative relation. This is different from the positive and concave relation that Kaplan and Schoar (2005) found but in line with findings from Humphery-Jenner (2012) and Lopez-de-Silanes et al. (2015). It supports the limited attention theory that states that an increase in fund size is associated with funds reducing the number of staff per portfolio company and the attention given to them. It can also lead to more difficulties in communication, agency conflicts, value-destroying buyouts and overpaying for transactions, which all leads to lower performance. The results regarding sequence indicate that contrary to what I expected, the effect of sequence on performance is not significant. This can be explained by the theory that the private equity market is maturing and becoming more competitive. The competitive advantage that established funds had over new ones decreases. As a consequence not only established funds have highly skilled general partners and new funds might perform just as well if not better. The signs of the coefficients are however in line with the hypothesis and indicate that raising another fund by the same private equity firm has a negative effect on performance.
Furthermore I analysed how the number of deals per fund and deal size can affect fund performance. The results regarding the number of deals are evidence against the hypothesis that it negatively affects performance. Instead I found a positive significant relation between the number of deals per fund and fund performance. This finding supports the idea that by doing a lot of deals funds can diversify and thereby reduce their unsystematic risk. The universe of investment opportunities is broader and besides that, repeated
interactions with other parties like banks can result in less information asymmetry and more favourable credit terms. Past researches that came to similar conclusions include Metrick and Yasuda (2010) and Ivashina and Kovner (2011). There are however also papers, among for example Cumming and Dai (2011) and Lopez-de-Silanes et al. (2015), that argued in favour of a negative relation between number of deals and performance. Contrary to my hypothesis, increasing the investment per deal does not have a significant impact on fund performance.
The positive signs of the coefficients however are in line with my expectations and theories described by for example Norton and Tenenbaum (1993), Gejadze et al. (2017), Cressy et al.
(2007) and Gompers et al. (2018). The positive signs support the theory that large
concentrated investments increase the fund’s industry-specific knowledge and network. This
can lead to them being able to advice and monitor their investments in a more efficient way and it can increase their ability to quickly respond to market signals.
In addition I performed multiple robustness checks to verify the validity of the results.
The first robustness check showed that past performance does not significantly affect a fund’s ability to raise capital and the main driver of fund size is the size of the previous fund. The second robustness check used the performance metrics KS PME and net multiple as dependent variables. From the results it can be concluded that the previous mentioned findings are robust to the choice of performance measure, since they again indicated that the number of deals that a fund does positively influences a fund’s performance and that the deal size does not have a significant impact. Another robustness check tested whether the effect of the size elements depends on the geographical focus of the funds. The sample was split into two different subsamples: funds that focussed on the U.S and those that focussed on Europe.
The results indicated that the positive effect of increasing the number of deals on
performance is only significant for buyout funds that focus on the U.S. Besides that, all other conclusions remained the same for both subsamples: the effect of deal size is positive but not significant, size has a negative impact on performance and sequence does not have a
significant impact on performance.
The results contribute to the debate of the size effect by suggesting that funds can benefit significantly from a high number of deals. This is especially the case for funds that are less knowledge-intensive and looking for more diversification. During times where investment opportunities in one industry/country are limited, diversifying into different industries and regions may be beneficial. The results also suggest that during times when profitable investment opportunities are scarce, a high investment per deal can drive the fund’s performance up. The findings have important implications for many different stakeholders.
The general partners are in charge of managing the fund size and investments. For them, knowing the effect of the different size elements on performance is fundamental to maximise fund performance. This in turn has implications for the investors in private equity firms. They will profit more when they invest in funds that effectively manage their size. The results also have important implications for the society as a whole. Private equity is often seen as an important drive of among other things production, employment and economic growth. So when funds optimise their size and thereby performance, it could lead to long-term improvements in companies, industries and the economy as a whole.
It is also important to recognise that this study has a few limitations. One limitation concerns the reliability of the data. With private equity it is difficult to obtain reliable
information and there is a risk of survivorship bias in the sample. This means that only funds that performed well remain in the sample and others drop out. This can result in
overestimation of the performance. Even though Harris et al. (2014) and Korteweg and Sorensen (2017) found no evidence that data from Preqin was biased, this potential bias should be taken into account. A second limitation is that there is still some unexplained variance in the model. This could mean that the model does not capture all determinants of fund performance and that there is an omitted variable bias. Future research could solve this by including more control variables. This thesis mentions that an increase in size can
decrease performance because it can lead to increased communication costs and less time and attention spent on each investment. However, due to data limitations, variables relating to the internal structure of private equity firms are not included to research this. For future research it could be interesting to include the number of staff per fund as a control variable and investigate how this affects the relation between fund size and performance. Furthermore, future research could include a proxy for communication costs, such as the diversity in the background of the management. Another limitation is that the sample consisted mainly of funds in the U.S. and Europe, which are both developed areas. It is therefore not certain whether the results are also applicable to funds in developing countries. So it would be interesting to do similar analyses for funds in developing countries. Despite these limitations this research presents some useful insights into the size effect of buyout funds and some explanatory insights into effective ways to influence size.
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